U.S. Real Estate Securities - February 2012 Review & Outlook
Cohen & Steers
March 23, 2012
We would like to share with you our review and outlook for the U.S. real estate securities market as of February 29, 2012. The FTSE NAREIT Equity REIT Index had a total return of –1.1% for the month, compared with a +4.3% return for the S&P 500 Index. Year to date, the indexes returned +5.4% and +9.0%, respectively.
After a strong showing in January, U.S. real estate securities sold off in February, underperforming the broad equity market. Economic data continued the recent trend of slow but steady progress, including notably lower jobless claims, improving sales of existing homes and a generally strong consumer. As economists raised their forecasts, the momentum of economic surprises slowed, somewhat tempering investors’ optimism. Rising gas prices were also cause for concern, as oil prices spiked amid growing tensions in the Middle East.
REITs finished reporting fourth-quarter earnings during the month, and results were largely positive, with approximately two-thirds of companies exceeding consensus estimates. REITs generally benefited from low financing costs, accretive acquisitions and positive trends in net operating income for core properties. However, management guidance was less positive than the market expected, reflecting continued caution regarding the operating outlook.
Company news strongly influenced property sector returns
The industrial sector led with a +4.7% total return in the index. Its largest constituent, ProLogis, reported solid revenue growth due to occupancy gains, including surprising strength in its European assets. Overall, the sector benefited from improving economic activity, which helped counter headwinds from rent roll-downs, as tenants that signed leases during the peak of the 2007 market renewed at lower rates.
Among regional mall owners (+1.2%), companies with lower-quality properties outperformed, consistent with the market’s increased appetite for risk. Shares of General Growth Properties gained on news it would acquire 11 Sears anchor stores. The purchases will enable the company to make accretive additions of new in-line square footage, most importantly at the company’s Ala Moana property in Hawaii.
The health care sector (–4.2%) struggled amid the rotation into more cyclical assets, uncertainty about Medicare reimbursement rates and above-average valuations. Ventas shares slid after one of the company’s major tenants announced it would not renew several of its leases. On the positive side, Health Care REIT successfully completed a $1.1 billion secondary equity offering in an effort to reduce debt and pursue acquisitions.
Within the office sector (–0.7%), Boston Properties underperformed as investors rotated into higher beta positions. While this shift would normally benefit hotels REITs (–2.7%), the sector declined on concerns that higher oil prices might have a negative effect on travel and the economy at large. The apartment (–3.8%) and self storage (–2.6%) sectors also underperformed, as generally good earnings reports failed to meet the market’s high expectations. Improving sentiment in the for-sale housing market may have contributed to the apartment sector’s decline given the risk that more renters would seek to become homeowners.
We are encouraged by the recent trend of U.S. economic data showing measured improvement, including solid employment gains, as well as positive developments in Europe that have somewhat brightened the outlook for risk assets globally. With funding costs likely to remain low and demand showing signs of strengthening, we believe U.S. real estate fundamentals will continue to gradually improve in 2012, supported by a scarcity of new supply in most markets.
The fragile U.S. recovery is not without potential dangers, however. Our global investment team continues to closely monitor macroeconomic risks, including the potential effect of rising oil prices on consumer spending. We are also cognizant of risks related to political uncertainty in an election year, particularly with regard to the financial and health care industries, as well as the Washington, D.C. office market generally.
We have a generally favorable view of key office markets, including life sciences, technology and media, as well as New York offices broadly. We have decreased our allocation to apartments following their strong run in 2011. We continue to favor prime retail owners, while staying cautious toward health care properties, suburban offices and secondary retail. We are also underweight apartments, but we see opportunities in certain markets that should benefit from positive employment trends in the key 20-30 year-old renters demographic.
(c) Cohen & Steers